de Silva Wijeyeratne, G. (2009). Balancing Act. LMD. December 2009. Page 171. Volume 16, Issue 5. ISSN 1391-135X.
Applying liquidity managements concepts developed in banking into the leisure sector.

In a previous article in LMD I explained how I had introduced the concept of Mark to Market (MTM) accounting from my days as a banker in the Square Mile in London, into the tour operations business. The monthly reporting of liquidity was another feature I had learnt in Risk Management which I introduced to tour operations. The concept itself is nothing new to Finance Directors and Treasurers. Those who are in a privileged position to have a positive cash balance would try to maintain as positive a balance as possible to ensure that there is enough cash to cover several months of operations in a disaster scenario. Those operating on an overdraft have to optimise the cost of borrowing and ensure that lines of credit remained open. In fact I remember a conversation with Romesh Lokuge, the former Finance Director of Jetwing Hotels. He told me that he strived to maintain a cash balance to ensure that at least six months of operations could be covered. This self imposed criteria is analogous to the Capital Adequacy requirements imposed by banking regulators around the world in their supervision of banks.

Over the years, I moved the specialist wildlife subsidiary of Jetwing, a start up operation to a stage where it could maintain a positive cash balance. This required refraining from dividend distributions in favour of building up a liquidity cushion to tide us over difficult times. The next stage was to report the cash balances not just as a simple number of Rupees in a bank account. But to state in terms of months of survival in months of operation.

Lets look at simplistic example. Imagine a company incurs a monthly cost of Rs 1million, with cashflows averaging around the same amount. Lets also assume that it has a cash balance of Rs 5 million. It therefore has cash for five months of operations. This can be further refined by looking at a stress scenario. Assume that there is market crash and the in-flow of business stops. The creditors will still need to be paid (although in practice deferred terms may have to be negotiated). How many months can a company now survive for? The available cash balance will now have to be further reduced by the creditor balances on the balance sheet. However in a fire sale situation in a stress test, a receivable amount should also be assigned to assets on the balance sheet. Assets will need to have a receivable percentage allocated for it. For example, for fixed assets it would be zero. For liquid, tradeable investments in the equity market, the amount assigned could be a conservative fifty percent. For sovereign bonds of the highest grade it could be seventy five percent and so on.

In assigning what are termed ‘hair cuts’, the assumption is made that in a stress event, that even the most risk free and liquid assets ill not realise their usual values. This is particularly true if the stress event has arisen from a macro event which is outside the control of an individual company. Equity and debt markets could all collapse together rendering investments difficult to sell or have their values reduced. A stress event which is unique to a particular company or sector may not be so damaging. But in modeling the liquidity survivorship, it is best to assume the worst.

If we return to the simple example, we may find that the cash balance of Rs 10 million can be supplemented by another 5 million. But if existing obligations to pay amount to say 15 million, then the available cash has reduced to Rs 2.5 million. This is equivalent to two and a half months of operations.

In a highly leverages business or in a start up, the ‘months survivorship’ can be small or even negative. Setting liquidity criteria sets a brake on aggressive, leveraged expansion. Therefore it also brings into play the risk appetite of an organisation. It is useful for a board to see the ‘months survivorship’ charted for each month end. When I worked in the Group Risk team of Abbey National, the liquidity analysis was a standard schedule in the pack of papers for the Asset and Liability Committee (ALCO). Abbey national was then the fourth largest retail bank in the UK. It watched its liquidity, daily, like a hawk. I did not realise then that a few years later I would migrate some of this thinking into running a subsidiary in the leisure sector.

The ‘months survivorship’ in liquidity terms, is one of a number of indicators or dials on the dash board to provide a navigational aid for managing a business. As with anything, an indicator by itself is often of little value. It is how it is used and how judgment is exercised that matters.